Monday, June 10, 2013

Jeremy Warner tries to criticise full reserve banking in the Telegraph.

Given that Jeremy Warner has views on the debt and deficit that make Rogoff and Reinhart look like beacons of enlightenment, this article of his in The Telegraph on full reserve banking isn’t too bad.

I wouldn’t expect anything very sophisticated from a bog standard newspaper economics correspondent like Warner on the full versus fractional reserve argument. Getting to grips with the latter argument takes a lot of time, and the Warners of this world have too many other aspects of economics to keep up with to be able to get to grips with the full versus fractional argument.

Anyway, he is quite sympathetic towards full reserve, but the main criticism he makes of it is easily demolished. He says (in colour): “One of the most obvious drawbacks is that there would plainly be less credit and less leverage in such a system. Indeed, to the extent that credit existed, it would look much more like high-risk equity. For all the social and economic scarring the credit cycle can inflict, it is also a key part of the creative destruction of capitalism.

Without it, you might have a more stable economy, but it is not clear that you would have as much innovation, entrepreneurialism, business creation and long-term economic growth.”

Let’s run through that.

As regards his claim that there would be less credit, that’s a statement of the obvious. Full reserve does indeed prevent private banks creating money out of thin air and lending it out. The latter is more or less the definition of full reserve.

He then seems to suggest that that lack of credit would be made good to a greater or lesser extent by equity funded investment. Quite right. But why does he need to insert the phrase “high risk”? The average stock market investment is not “high risk”.

In short, replacing a proportion of investments funded by bog standard bank loans with investments funded by bog standard stock market (or other equity type investment) funding does not of itself mean a move to “high risk”. Put another way, it’s a trifle bizarre to claim that bank loans are relatively risk free: we’ve just had a disastrous credit crunch followed by an equally disastrous recession, all sparked off by silly bank lending behaviour, haven’t we?

Next he claims that the “credit cycle” is part of the “creative destruction of capitalism.”Complete nonsense!

Even if there were no “cycle” at all, numerous firms would continue to go bust every week, and numerous new firms would be set up every week. The “cycle” is totally unnecessary for that “creative destruction” to take place.

Warner than claims that the transition from fractional to full reserve would be “highly destabilising”. Really? Problem is he doesn’t give any reasons.